This is good for EMES in my opinion. Snackman
Crude Oil Heads For A New High In 2017
Nov. 3, 2017 11:41 AM ET|
Andrew Hecht
Andrew Hecht
Commodities, long/short equity, medium-term horizon, long-term horizon
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Hecht Commodity Report
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Summary
Higher lows and higher highs since June 21.
Brent breaks above $60 per barrel, and the market tightens.
Oil products and inventories continue to provide support.
OPEC meeting could cause volatility.
How high can nearby NYMEX futures rise?
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On Wednesday, November 1 the price of NYMEX nearby crude oil futures traded to a high of $55.22 per barrel and then closed the session at $54.30 disappointing those who were looking for a breakout in the energy commodity. Critical resistance for NYMEX crude was at the 2017 highs established back in January at the start of the year at just two cents above the November 1 highs. The first attempt at conquering technical resistance and putting in a new peak for the year failed.
Crude oil is one of the most closely-watched commodities that trade on futures exchanges around the world. While two-thirds of the world’s crude oil use the Brent price as a pricing mechanism for physical transactions, the most liquid futures market for the energy commodity is listed on the New York Mercantile Exchange (NYMEX) division of the Chicago Mercantile Exchange (CME). The NYMEX contract calls for delivery of West Texas Intermediate crude oil that is a North American product. WTI crude is sweeter oil; meaning it has lower sulfur content than Brent. Meanwhile, the WTI crude tends to be cheaper and easier to refine into gasoline while the Brent oil is more suitable for processing into distillate products. Gasoline is the most ubiquitous oil product and WTI traded on the NYMEX tends to attract the most speculative activity as market participants depend on liquidity when it comes to high levels of volume and open interest. Open interest is the total number of open long and short positions in a futures market, and the NYMEX contract has a history of the highest level of open interest of all commodities futures. Therefore, while WTI oil only accounts for one-third of the world’s pricing, it takes the gold medal when it comes to a trading instrument.
The price of crude oil is a barometer for the health of the global economy, inflationary pressures, and the supply and demand for the world’s energy market. Since June 21, the price of NYMEX crude oil has been moving higher, and market structure in the oil market continues to support strength in the price of crude oil, even at the current highs.
Higher lows and higher highs since June 21
On June 21, the price of NYMEX crude oil violated technical support at the November 2016 lows at $42.20 per barrel. As the price of the energy commodity approached that low, many analysts pointed to an oversupply of the energy commodity and called for the price to fall to $40 per barrel or below. However, while nearby NYMEX futures made a lower low, it quickly turned around and commenced a rally that has lasted for the past four and one-half months.
Source: CQG
As the weekly chart highlights, NYMEX futures fell just 15 cents below the November 2016 low on June 21 and has been making a series of higher lows and higher highs since. On November 1, the nearby contract traded above the $55 per barrel for the first time since the first week of 2017 but it reached just two ticks shy of the high for the year when it traded to $55.22 per barrel.
Technical indicators for the crude oil market, now that it is close to breaking a technical resistance level on the upside, present conflicting data. The trend, as exemplified by the slow stochastic is rising, but it is in overbought territory which means it could run out of bullish steam and a correction to the downside could be ahead. Open interest had increased to 2.528 million contracts as of November 1 which is the highest level in history. While rising price and increasing open interest tend to validate a bullish trend in futures markets, it is likely that there are lots of trend-following speculative longs in the crude oil market given the price action over recent months. Speculators buy a commodity like crude oil to sell it at a higher price, and like in a game of musical chairs when the trend turns many run for exits which poses a danger for the price of the energy commodity. At the same time, while the trend in the oil market appears bullish it looks about as good as it looked bad back on June 21. Crude oil looked like it was about to fall into the abyss back in June, but the price could only manage a move that was 15 cents below support and a new low for 2017. On November 1, the energy commodity only rose to a level that was two cents below resistance and has yet to put in a new high for this year.
On a technical basis, one could make a strong case for a price correction, and perhaps crude oil will decline and spend some time consolidating and building cause for another run at the highs for the year. When it comes to the fundamentals of the energy commodity, its market structure and supply and demand equation continue to provide support for the price.
Brent breaks above $60 per barrel, and the market tightens
While WTI crude has not made a new high for this year on its move on November 1, Brent crude oil has broken out to the upside from a technical perspective.
Source: ICE
As the weekly chart of Brent futures that trade on the Intercontinental Exchange illustrates, the highs for 2017 dating back to early January stood at $58.37 per barrel, and that price gave way back in late September when the price rose to $59.49. However, this past week the price of Brent surged to highs of $61.70 and was trading around the $60.50 level at the close of business on November 1. Brent has strengthened compared to WTI over recent months for several reasons. First, higher oil prices have depressed the price of WTI compared to Brent as selling from U.S. shale producers has weighed on the price of the NYMEX futures contracts. Second, production cuts from OPEC announced late last year have decreased output which has provided support for Brent compared to WTI crude. Third, the geopolitical landscape in the Middle East which uses Brent as its pricing benchmark has caused supply fears. The ongoing conflict between the Saudis and Iranians has resulted in a proxy war in Yemen. The current blockade of Qatar by Saudi Arabia and many of their Gulf State allies has increased the prospects for violent flare-ups in the region. Any increase in tension could impact production or logistical routes for the energy commodity. Finally, China has been on a tear when it comes to buying industrial commodities, and it is likely that the world’s leading commodities consumer has been stocking up on crude oil to increase the level of their strategic petroleum reserves. Chinese buying, from a logistical perspective, is likely to be tied to Brent pricing contracts thus increasing the premium of Brent compared to WTI.
Source: CQG
As the weekly chart of WTI minus Brent nearby crude oil futures shows, the Brent premium stood at around the $2 level at the beginning of 2017 and was trading close to that differential on June 21 when oil hit its low for the year. However, over recent months, the premium for Brent has increased for the stated reasons, and reached a high of $7.15 per barrel in late September and was trading at the $5.83 level on November 2. The increase in the premium caused Brent crude oil to rise to a new high for 2017 while WTI remains below the elusive level, for now.
When it comes to the forward curve for the two crude oils, the term structure has tightened which is often a bullish short-term signal for the oil market.
Source: CQG
The price of December 2018 minus December 2017 NYMEX crude oil futures shows that the spread has moved from a $2.31 contango on June 21 to a $1.60 backwardation on November 1. Forward premiums for NYMEX crude oil have turned to discounts as the price of nearby futures rose. The move in term structure is likely the result of an increase in shale producer hedging activity which serves to depress deferred prices as producers lock-in prices for future output. However, it is also a sign of short-term supply concerns and the action in the Brent forward spreads has been a sign that the market has indeed tightened over recent months. The January 2018 versus January 2019 Brent spread was trading at a $2.93 backwardation as of the close of business on November 2 while the same NYMEX spread was at a $2.07 backwardation. Term structure is just one piece of the market structure puzzle for the energy commodity, but others are also providing bullish signs for the price of crude oil.
Oil products and inventories continue to provide support
Crude oil inventory data has been supportive for the price of the energy commodity in the United States. The move to highs of $55.22 on November 1 was likely the result of weekly inventory numbers from the American Petroleum Institute ((API)) on Tuesday, October which received some degree of validation from the Energy Information Administration ((EIA)) in their release on November 1. The API told markets that crude oil inventories declined by a whopping 5.09 million barrels for the week ending on October 27 and the EIA said the decline in stocks was 2.4 million barrels. Both numbers exceeded market expectations for a withdrawal from inventories. At the same time, there were also withdrawals in the product markets. The API said gasoline inventories fell by 7.7 million barrels and the EIA reported a 4 million barrel decline. When it comes to the distillates, the API said they dropped by 3.11 million barrels while the EIA reported only a 320,000 barrel decline. This was not the first week that inventory reports supported the price of crude oil and triggered buying and economic growth in the United States and around the world continue to be supportive of increasing demand for crude oil and products. While the price of crude oil has been rallying for over four months, products have outperformed the raw energy commodity which is supportive for more gains in the commodity that is the input in their production.
Source: CQG
The trajectory of the December NYMEX gasoline crack spread shows that it has appreciated steadily since May. Even though we have been in the offseason for gasoline demand in the US since September, the oil product continues to outperform crude oil adding support for the energy commodity. The latest price spike on Thursday, November 02 came on the back of an outage at the Wales refinery which has caused Valero to pull gasoline from other regions of the United States to satisfy requirements.
Source: CQG
The trend in the December NYMEX heating oil crack spread which is a proxy for other distillates like jet and diesel fuels shows a similar trajectory over recent months as oil products could be signaling that we have yet to see a high in the price of crude oil. Both oil products have outperformed crude oil at a time when the oil price experienced a significant rally. From the lows on June 21 to the highs on November 1, the price of crude oil has appreciated by over 31%. Over that period, demand for oil products has continued to rise, and the prices have done even better than the commodity that is the input in their production. The bottom line is that oil products continue to support the price of the energy commodity and a new high for 2017.
OPEC meeting could cause volatility
The oil ministers of OPEC will attempt to put aside their individual issues with one and other when they gather in Vienna, Austria on November 30 to decide on production policy for the coming six months. At their last meeting in late spring, the cartel extended production cuts until the end of the first quarter of 2018. It is likely that OPEC will now continue the quotas until the end of 2018 at their upcoming meeting. In a pow-wow in Moscow last month, the King of Saudi Arabia and Vladimir Putin likely agreed to a deal that would extend production cuts. The two biggest oil producing countries are unlikely allies considering Russia’s close relationship with the theocracy in Iran. While not a member of OPEC, Russia had served as an unofficial mediator since last year when they successfully arranged for the cartel to abandon their strategy to flood the market with petroleum and negotiated production quotas for member nations. A higher and stable oil price is a necessity for all parties involved. Russia, Iran, the Gulf States, Qatar, and all other members of the cartel depend on oil revenues. When it comes to Saudi Arabia, the valuation of the coming IPO of Aramco that will capitalize the Kingdom’s sovereign wealth fund depends on the price of crude oil. The IPO is likely to be the biggest in history with a market cap of over $1 trillion, and the Saudis are relying on a successful sale of shares to diversify away from petroleum in the future.
There is likely to be lots of horse trading, threats, and moments of concern leading up to the OPEC meeting at the end of this month. After all, getting the membership to agree on anything is like trying to herd wild cats. During periods of doubt, we could see some violent corrections in the price of oil. However, vested interest is likely to prevail, and a continuation of quotas until the end of 2018 will prove supportive for the current price of crude oil.
How high can nearby NYMEX futures rise?
Crude oil has already reached my target which was the highs of 2017. I consider falling two cents short a victory considering it came from the $42.05 level. When it comes to the future, I could easily see the price rise to the $60 per barrel level given the current state of term structure, inventories, and product prices. At the same time, I have a nagging feeling that the price action when oil made a new low on June 21 could repeat when the price finally rises above the $55.24 per barrel level on nearby NYMEX futures. After all, long crude oil has become a crowded trade and nothing fuels a correction like stale longs heading for exits. It would be ironic if the energy commodity were to rise to just 15 cents above that critical resistance level and then fall back to the sweet spot for WTI light sweet crude oil at $50 per barrel in a mirror image of the price action from June. The bottom line is that anything is possible when it comes to commodities market and the geopolitical landscape is anything but stable these days. I am flat crude oil at this time, but if I had a gun to my head, I would have to remain long even though I would be one of many. I am waiting for the analysts who called for prices in the $30s in June to call for oil in the $60s or higher. When the bulls come out of the woodwork, it will be time to sell and even go short the energy commodity. I still believe that $50 is the pivot point for crude oil. A price that is double the February 2016 low and half the June 2014 high is a number that producers and consumers alike can agree satisfies their desire for stability. However, right now the bulls have the reigns of the market and producers tend to be pigs when it comes to price appreciation. Someone should remind them that in the volatile commodities markets where trends can turn on a dime, hogs are not pets and they go to slaughter. As I write this piece on Thursday evening November, 2 December NYMEX crude oil futures are trading at the $54.80 per barrel level and Brent January futures are at $60.87 per barrel.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
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